WHAT IS GOING ON WITH RATES?

With all the craziness that is our current economy, I have quite a few clients and friends who are trying to predict not only the bottom of the real estate market, but also the future of mortgage interest rates. Let me tell you, as long as I have been doing this I am increasingly convinced that timing the market, or predicting rates is just about as impossible as lighting a match in a lighting a match in a thunderstorm: try as you may, your success will be short lived at best.

I am not a Realtor. I own homes, all of which are loosing value faster then I would choose. I am not licensed to give advice on Real Estate value, sales prices or investment opportunities.

I am, however, a licensed Mortgage Loan Professional. That license means that I have taken a bunch of hours of education and have passed a couple of exams. More significant than the fact that I have a license is the time I have spent working in this industry. I would consider myself a bit of an expert. As an expert, I will say right here and now: NOBOBY KNOWS WHAT WILL HAPPEN TO RATES! You can line up 10 experts and chances are you will see 6 or 7 difference opinions about what the next few months will bring.

That being said, there are some indicators which have traditionally provided some hints about what is coming. Probably the most common is the Treasury Bond Market.

Allow me to explain:

Interest Rates for mortgages tend to be just slightly above the rates for US Backed Treasury Bonds. Essentially, a bond is a large loan to a company or organization such as a city or state government. Like stocks, bonds are frequently packaged into mutual funds, allowing individual investors to participate in the bond market. Bonds are sold at a fixed interest rate, so traditionally in times of economic downturns many investors are more comfortable investing in bonds rather than slumping stocks. When the stock markets are doing well people are less interested in bonds, therefore the value of the bond goes down.

The Bonds that specifically affect mortgage rates are known as Mortgage Backed Securities. In simple terms, a Mortgage Backed Security is comprised of several loans that are bundled together and sold as an investment. When a loan is closed, the lender will turn around and sell the new note to Fannie Mae or Freddie Mac or the less common Ginnie Mae. By selling the note, the original lender gets its money back and can in turn write loans to new borrowers.
Fannie, or Freddie or Ginnie then takes that loan and others similar to it and bundles them together into a security, or investment vehicle. The new security is said to be backed by mortgages because it is backed by the loans and the repayments of those loans. Individual investors can then invest in these securities which allows Fannie and Freddie and Ginnie to go back to the original lenders and purchase more loans.

To the average homeowner, not much has changed. When you make your payment to “ABC Bank” they become the Servicing company, meaning they take a small % and then pass the rest of your payment to Fannie Mae, etc. Fannie then takes a % as profit and then passes the rest on to the investors who own the Security.

So how does all that affect the Bond and your rate? Simple—at least as simple as complicated financial and debt strategies can be!

When demand for a Mortgage Backed Security goes up, the price of the security also goes up. That means that the Yield (the amount the investor will make in return) goes down. If the demand is low, the price will drop, meaning that the yield will increase. Perhaps it is best to look at it this way: In order to create incentives to create more demand (and thus higher prices) the institutions selling the securities will increase the Yield (the payoff to investors). The only way they can increase the amount they pay investors is to increase the amount the homeowner pays.

Thus, High Yields on Mortgage Backed Securities lead to higher interest rates. Said another way, Low Prices of Mortgage Backed Securities lead to higher interest rates.
So how can you know what to expect? Watch the Treasury Bond Market. Specifically the 30 year bond. If the Yield is low, chances are your rate will be low. If the Yield is high your rate will be high. If the bond is trending down you can expect to see rates increase, however if the bond is trending upward you can expect rates to come down.

I know I could have just told you that, but then you wouldn’t have learned so much about one of the main contributors to our current economic mess.

As usual, if you would like additional information, shoot me a line at jayhart@cottonwoodmtg.com